Many employers are waking up to a vexing pay issue: pay compression, made more troublesome by pay transparency laws. Pay compression occurs when companies give higher-than-normal wages and salaries to new hires, often during times of labor shortage, but do not pass on similar pay increases to their current employees. This sometimes leads to higher pay for new workers than for tenured workers.
Tenured workers can become disgruntled when they learn about equal or higher pay for new workers, causing them to consider leaving the organization for higher pay. This can lead to a disastrous and costly turnover spiral for companies. It is always the best workers who leave first.
Many executives like to believe their employees will not catch on to the higher wages or bonuses paid to new hires. They are mistaken. An adage applies here: When more than three people know a secret, it will no longer remain a secret. This is especially true for pay. The only safe assumption is that employees will hear about these higher wages and compare new hires’ pay to their own pay.
Employers cannot legally discipline employees for discussing pay or other working conditions. Employees are legally protected by the National Labor Relations Act (NLRA) when speaking about what they earn. According to the National Law Review, “The National Labor Relations Board (NLRB) has taken the position over the years that employees have the right under the National Labor Relations Act (NLRA) to discuss their ‘terms and conditions of employment’ with one another, including their wages and benefits. This right applies in union and non-union settings. Accordingly, the labor board routinely finds companies who prescribe rules that forbid employees from discussing their rates of pay or similar issues to have violated the NLRA.”
Pay Transparency Laws Expose Pay Differences–And Has Some Benefits
Pay compression is more complex today than a decade ago because we live in an era of more prevalent pay transparency laws, which, at a minimum, require employers to include salary ranges when posting jobs. Ten states have implemented such laws, though degrees of pay transparency vary by state.
More employers are also including a range of non-cash benefits, perks, and flexibility options in their job postings, according to a recent ZipRecruiter survey on pay transparency. The survey found that 72 percent of employers post pay information on all job listings (not only where required to do so by law), taking the percentage of postings with salaries listed into the range of 50 to 60 percent on ZipRecruiter. Studies looking at Indeed job postings have found similar trends.
The ZipRecruiter survey also found that 75 percent of employers agree that pay transparency helps them attract quality candidates. Similarly, 61 percent of respondents agreed that pay transparency makes recruitment more efficient by discouraging poorly matched candidates from applying and by preventing post-offer disappointment. ZipRecruiter marketplace data confirms that job postings that include salary data receive 50 percent more applications, on average, and are three times more likely to deliver quality candidates.
Finally, the ZipRecruiter survey found that 44 percent of employers worry that pay transparency could discourage top talent from applying for their roles because competitor companies post higher pay. While employers want to avoid publicly posting high wage rates and setting unrealistically high expectations, they also don’t want to set pay too low and deter high-quality candidates from applying.
As an employer, you must address pay compression, or your higher-performing employees will leave for higher-paying employers — unless you can provide valuable equity that other employers cannot. These equities can be things like company stock or hybrid work options.
Cost of Turnover
Turnover caused by pay compression is costly to employers. Gallup has estimated that voluntary employee turnover costs US businesses $1 trillion a year. The turnover cost for non-exempt staff can be 20 percent of their salary per year. For engineers, the cost can be as much as 50 percent of their salary per year, and for executives, 200 percent. Many organizations learn that reducing the cost of turnover, especially among their highest-skilled or most valuable employees, significantly drives profitable growth. Learn more here.
Fixing Pay Compression
Addressing pay compression is relatively easy. Calculate the difference between the average new hire starting wage by job title and the average wage for tenured employees, then add that difference to the wages of the tenured employees. The timing of this can be a special adjustment before the annual salary plan, or if there is urgency, before the annual pay cycle. Some organizations limit these pay compression adjustments to their most valued employees, although I recommend taking a broader approach. Pay compression adjustments should not replace annual salary plan pay increases.
Pay compression and transparency will be the #1 salary issues in 2024. Ignoring these issues may damage employee morale and increase turnover — both of which are costly problems that can impede your business strategies.
About Victor
Victor Assad is the CEO of Victor Assad Strategic Human Resources Consulting and Managing Partner of InnovationOne, LLC. He works with organizations to transform HR and recruiting, implement remote work, and develop extraordinary leaders, teams, and innovation cultures. He is the author of the highly acclaimed book, Hack Recruiting: The Best of Empirical Research, Method and Process, and Digitization. He is quoted in business journals such as The Wall Street Journal, Workforce Management, and CEO Magazine. Victor has partnered with The Conference Board and the US Department of Energy on innovation research. Subscribe to his weekly blogs at http://www.VictorHRConsultant.com